SEC changes course on short-selling ban

(Crain's) -- Staff at the U.S. Securities and Exchange Commission has recommended amending an emergency ban on short-selling, avoiding a move that threatened to choke trading at the Chicago Board Options Exchange and hurt business at Citadel Investment Group's market-making arm.

Both have handled record volume amid the financial crisis this past week.

In selling short, investors borrow stock to sell, betting it will decline and hoping to profit by buying it back at a lower price. Manipulative short-selling may have fueled the rapid declines of some financial stocks this week, the Securities and Exchange Commission says.

Following criticism of short sellers from politicians, the SEC imposed a two-week ban on such trading in all 799 U.S. financial stocks. Stock markets rallied on Friday partly because of the ban.

But midafternoon Friday, the SEC decided to change terms of the ban that had rankled options traders.

The original order, issued in the middle of the night, had failed to exempt options market makers, even though such traders use short-selling to protect against losses in their day-to-day business, not to bet on markets. Without an exemption, CBOE market makers -- whose jobs are to ensure smooth trading by standing ready to buy when an investor wants to sell -- said they would've been unable to do their job properly.

The SEC's reversal came after a concerted lobbying effort by the Chicago Board Options Exchange and the Chicago-based Clearing Corp., whose lead lobbyist, Susan Milligan, had called the plan a "potential complete disaster."

The short-selling ban on market makers would have imposed "a huge cost to the retail investor," said Peter Bottini, an executive vice-president at Chicago-based OptionsXpress Inc. Options exchanges were "very upset and (were) scrambling" to get exemptions extended for next week, he said.

In a statement Friday, CBOE Chief Executive William Brodsky said, "It is difficult to comprehend the merits of a draconian measure that will result in the sudden and severe removal of liquidity from the marketplace at the same time that the government is taking unprecedented steps to preserve it."

Mr. Brodsky was in Washington, D.C., asking regulators and lawmakers to intervene. "The lack of relief for options market makers will have serious ramifications for the reliability of the options market and for the efficiency of our capital markets overall," he said.

Chicago-based Citadel handles about 26% of all U.S. options trading. CBOE handles about 33%. Trading in options on financial stocks accounted for about 12% of all U.S. options volume through August. A spokeswoman at Citadel declined to comment.

Not everyone in Chicago agreed that market makers should get an exemption.

Jon Najarian, co-founder of market commentator optionmonster.com, says he disagrees with the ban on short-selling, but if such a ban is in effect, it should apply to everyone. Otherwise, "all the bad guys will find a way to use someone's exemption to get around it," he says.